What is Bubbling Away Under The Surface? The Big Opportunities That Are In Plain Sight
Since I’ve referenced a dollar freefall in the headline, you might have guessed that it’s time to get a good long-term perspective on what's happening in the US dollar.
So here’s the 45-year chart of the USDI (US Dollar Index):
USDI measures the dollar against a half dozen major currencies. While this is somewhat of a lagging chart, it does give you the big picture.
Over the past 10 years, we've seen an enormous rally in the US dollar which took the Euro down from 1.60 all the way to 1.02. But despite this large and extended rally, the USDI has been making successively lower highs over 45 years.
This creates a bearish descending triangle pattern for the dollar. A few months ago, I began to speculate that the dollar was going to turn lower. Today it’s beginning to confirm the double top I identified right at the trendline of that triangle.
In fact, the Euro has appreciated from 1.06 to 1.19 recently, and I don’t think that run is done yet.
That’s because there’s still a lot of room for the dollar to fall to 85 or thereabouts on the 45-year chart. So USDI should weaken substantially over the coming months and years.
Here’s a monthly chart of USDI so we can drill down to look at the price action in more detail:
The double top on the long-term 45-year chart is apparent on this monthly chart. The second of the two tops formed during the height of the epidemic when there was an enormous fear-based rush into dollar liquidity.
Now USDI has turned lower and is approaching the prospective neckline of that double top.
A double top is a reversal pattern, so it’s likely that we’ll see a downtrend establish itself once that neckline has been breached. (There was an uptrend going into the double top and soon the reverse should be true.)
This is somewhat of an early call as that USDI neckline isn’t breached yet, but all the signs are in place for it to happen. That thesis holds up when we look at the weekly chart of USDI too:
Again, it’s obvious how USDI hit a major resistance level and is starting to roll over with a double top.
On this weekly timeframe (each bar represents one week instead of one month as before), there’s also a bearish head and shoulders pattern which – like a double top – is also a reversal pattern. USDI has even broken through the neckline of that head and shoulders already.
And it certainly looks like there’s a lot more room to drop. Even if USDI pauses at the support line lower down, the overall trend is becoming clear.
To capitalize on this dollar freefall, the number one currency pair on my hit list is AUDUSD (the Australian dollar versus the US dollar):
AUDUSD prices recently fell through a major support level around the 0.67 level during the height of the pandemic panic. However, that’s proved to be a giant bear trap where anybody who chased those lower prices is now trapped if they didn't get out quickly enough.
AUDUSD is now moving up quite strongly as it establishes a very bullish price pattern: an inverted head and shoulders. On this particular pattern, the right shoulder is noticeably higher than the left shoulder and so the neckline slopes upward.
The implications of this sloping neckline are that AUDUSD could accelerate from the current price with substantial velocity. My expectation is while AUDUSD could temporarily stall at 0.73 – 0.74 at the indicated resistance line, ultimately this pair looks ready to burst higher in the very near future.
Second, on my list of currencies that should benefit from a weaker US dollar is GBPUSD (the Great British pound versus the US dollar) which has formed an Eve and Adam double bottom recently:
An Eve bottom has multiple low points and an Adam bottom has a single sharp spike.
From that Adam bottom, GBPUSD traced out an ascending triangle and broke out of that pattern just a month ago. Now it’s pushing against major resistance levels and looks ready to break out.
Those resistance levels are at 1.34 – 1.35 and after that, there’s lots of blue skies ahead. I see clear sailing all the way to 1.43 which is 1,000 pips higher than GBPUSD’s current price.
So while we might see some consolidation at current prices due to resistance, any pullback should be viewed as a buying opportunity. I think GBPUSD is about to reverse a major 10-year downtrend.
That downtrend’s sloping line was broken last week, so if GBPUSD can hold above it, then GBP should be strong across the board against most other currencies as well.
Now I want to discuss the Japanese yen (JPY) trading pairs.
This is somewhat of a nuanced discussion as I evaluate each currency pair on its own merits but at the same time keep the bigger JPY picture in context.
While the yen has been strong against the dollar, it does look like it's weakening against other currencies.
Here’s USDJPY (the dollar against the yen) which looks extremely bearish by almost any measure right now:
The governing pattern in USDJPY has been the head and shoulders with a double top acting as the head from five years ago. That pattern has controlled the overall trend in USDJPY all this time as the pair has continued to trade in a descending triangle.
The market looks set to go lower, especially when you look at the most recent head and shoulders with a double top within that triangle. Everything looks like a green light for lower prices, right?
But as much as I focus on trying to find opportunities to capitalize on monster moves, I'm also looking for where the potholes might be. Where are the traps?
The recent price history at the neckline of this triangle is making me think twice about shorting this pair right now. Perhaps I’m over-thinking it, but there are some substantial support bars which have propped up this pair and weakened the bearish case. They look suspiciously strong when they really shouldn’t be.
So while the yen looks stronger against the US dollar at the moment, the fact that the yen is weakening against many other currencies makes me less bearish on this particular pair now.
So if I’m betting to short the dollar, I strongly prefer to go long AUDUSD first and then GBPUSD second before considering USDJPY as a short.
Let’s look at another JPY pair to see why I feel the yen is weakening.
Here’s GBPJPY (the British pound versus the Japanese yen):
Just like USDJPY, there are governing price patterns in GBPJPY starting with a head and shoulders that formed five years ago. This very bearish price pattern controlled the direction of prices for many years.
That includes the more recent rounding top, and normally this too would be bearish.
However, recent price action has been going somewhat contrary to that expectation. While GBPJPY has rallied several times only to subsequently collapse, the ongoing rally right now feels much stronger than earlier iterations.
The current rally has been doggedly hugging an uptrend line for the last several months in a very steady fashion. It’s making consistent higher lows. This isn't really consistent with a bear market.
I'm not ruling out that this rally could collapse, but GBPJPY is looking suspiciously like it has bottomed and is getting ready to smash the earlier bearish trend with a major rally.
Meanwhile, another pair that’s also at an inflection point is EURJPY (the Euro versus the Japanese yen):
The governing price patterns here including a head and shoulders and then a double top which have held prices in a sustained decline until very recently.
EURJPY has rallied and consolidated. From here, it could turn down in accordance with the downtrend or else break out and go substantially higher. In most either/or cases like this, I’m happy to defer to the market.
But this time I’m getting the feeling that EURJPY has bullish momentum on its side.
That’s because the most recent pattern is a double bottom, which is bullish. Could it be the governing pattern going forward? Could it generate even a modest but profitable rally like the earlier double bottom shown on this chart? (That rally did well until it peaked out with the double top.)
History like this is why I’m getting suspicious that we could be seeing a paradigm shift in the Japanese yen trading pairs where long-term downtrends get broken.
After all, EURJPY has already broken the neckline of that double bottom, which is bullish. It still looks strong, and what doesn't go down is going up instead.
Now you don’t need to rush in here and buy EURJPY. You can just watch and see what happens, which could very well be continued consolidation before EURJPY makes its move up or down.
But I want to draw your attention to this because a major weakening in JPY would be a trend reversal we haven’t seen for several years and it could be very profitable as it materializes.
It’s time for a look at precious metals …
This is XAGUSD (spot silver) which looks somewhat like AUDUSD with an inverted head and shoulders and a sharp move up since the neckline was cracked.
Silver has transformed from a bear market to a bullish market and has begun to consolidate with a series of inside bars.
Silver is still very bullish. In fact, the more silver consolidates here, the better the launching pad for a continuation of what looks like a new long-term bull market.
However, beware of the significant volatility. Silver can move three, four, five, even six dollars in a week. That makes it difficult to set up your risk/reward parameters.
If you’re an aggressive trader, the way to approach this is to take smaller positions over time as you gradually build a larger position. Obviously, I’m expecting a breakout to the upside at some point. (That being said, the high volatility means silver could first drop lower before exploding higher– that’s definitely a danger in when markets gyrate around as much as this one.)
I typically stand aside and wait in these situations. But if you really have to trade, consider placing a buy stop above last week’s high with a stop loss below last week’s low. That’s several hundred pips so be sure to allocate a small position if you’re determined to attack the market that way.
Now here’s XAUUSD (spot gold).
The enormous rally in gold started with a bullish price pattern. (There's almost always some basic pattern we can identify before a major move gets started.)
In this case, it was a double bottom all the way back in 2015 which was flanked by multiple shoulders on each side to create a complex inverted head and shoulders. This is a very bullish pattern and once gold finally broke above the neckline at $1,360, the bull market was ready to get started.
In the last couple of weeks, gold has been forming a small symmetrical triangle that could break out one way or another. While the momentum is clearly up and the path of least resistance is higher, the huge expansion of volatility could make for some messy turbulence before the main trend resumes in earnest.
Gold did trace out a bullish key reversal last week where it made a new low but by the end of the week it closed on the high. Perhaps that will lead to higher prices immediately.
On the other hand, there are now four weeks in a row of lower highs in gold. So this could be just a pause that refreshes or it may mean gold needs considerably more consolidation.
For now, I’m staying on the sidelines. Perhaps I'm being too conservative, but for now, I’d rather wait.
If you insist on trading gold, then apply the silver strategy I just suggested. Place a buy stop above last week’s high and your stop loss below last week’s low. However, that's a mammoth risk factor due to the price ranges involved. The way to control that is to put on only a very small trading position.
I'm going to finish off this week with a quick look at the US stock market, specifically the S&P500 which is trading right at the upper bounds of a massive reverse symmetrical triangle:
Just because the S&P is at a resistance level doesn't automatically mean that this is a double top.
After all, this is a big bad bull market, just like gold and silver. The path of least resistance is higher and right now it’s unwise to fight this thing and its very sharp uptrend.
With interest rates so low (actually there are negative returns on bonds when you price in inflation) plus the stimulus that's coming from the Fed and the Congress, this market is being buoyed by a flow of easy money.
The Fed has indicated that it will be the buyer of last resort and so assets are floating higher. I wouldn’t stand in the way of this until we see a definite reversal pattern of some kind.
And that’s it for the week!
To summarize, I’m bearish on the US dollar and I like AUDUSD and GBPUSD as the best ways to play that weakness. I’m also thinking that JPY could be weakening across the board, although perhaps not against USD. I’m bullish on silver and gold but concerned about risk-based volatility. Be careful with positions sizes if you trade either precious metal.
And with that, I wish you a very healthy and prosperous trading week.
Mark "DollarFreefall" Shawzin